Michael de Laine

By Michael de Laine, Copenhagen, 30th November 2008

After several years with a strong cyclical position, Denmark can expect negative growth and increasing unemployment in the near future, the chairmanship of the independent Danish Economic Council (the economic ‘wise men’) said in their latest report on the country’s economy, released last week. One of the consequences is the need for an expansive fiscal policy in the form of a tax reform from 2010.

The outlook for the global economy has worsened significantly over the last months, and negative growth rates are expected for both the US and several European economies, the economic ‘wise men’ said. Like many other countries, the Danish economy has been hit by the financial turmoil and slowdown of the global economy.

The financial crisis is intensifying the economic downturn on Denmark’s export markets. Combined with deteriorating Danish competitiveness due to higher wage increases, this is expected to cause very low growth in exports in the coming years, while import growth is expected to decrease, the ‘wise men’ said.

The chairmanship of the Economic Council see negative economic growth in 2009 and 2010, but with renewed positive growth in 2011. Inflation has risen, primarily caused by increasing food and energy prices, but also by increasing wages, but the rate of increase is expected to fall. In 2008 inflation is expected to be around 3%, falling to about 2% in 2009 and remaining at about that average level to 2011, the ‘wise men’ predicted.

Unemployment has recently come to a historically low level of 45,000 persons – 1.6% of the labour force. And it is expected to increase to around 120,000 persons in 2011. The latest jobless figures, announced the following day, showed a rise to 1.7% of the labour force, underlining the predictions of the ‘wise men’.

The low unemployment has led to increased wage rates, which is problematic as the wage rate increases are much higher than in the Danish export markets. Furthermore, productivity has fallen, resulting in a significant reduction in competitiveness. Because of the increase in unemployment, the wage increases are expected to fall, but they will continue to be significantly above foreign wage increases.

Danish consumers are also directly affected by the financial crisis, the ‘wise men’ said. Higher interest rates make it more expensive to borrow, and there are signs that credit conditions have been tightened. House prices will continue their recent falls in the coming years to the level in 2005, a drop of about 20% over the coming four years, due to higher interest rates, the financial turmoil and expected lower employment.

Very low consumer confidence, decreasing house prices and lower employment will lead to very low growth in private consumption in the years to come, though tax reductions in 2008-09 can support consumption to some extent.

Attempts to keep unemployment at the current low level through an easing of fiscal policy will only lead to larger imports, accelerating wage increases and a serious deterioration of competitiveness, the ‘wise men’ said. They added that fiscal policy should not be expanded relative to the planned policy in 2009.

However, if the economic development follows the forecast of the chairmanship of the Economic Council, Danish production and employment will fall to a level that is lower than in normal business cycles, and it is likely that the production level in 2011 will be even lower. In this situation it is natural to consider an easing of the fiscal policy, the ‘wise men’ said. An appropriate expansive fiscal policy could be to introduce a tax reform in 2010.

“The present Danish tax system is subject to increasing pressure,” the ‘wise men’ said in their report. “Globalization implies that various tax bases are becoming more vulnerable to international tax competition as capital and labour are increasingly mobile internationally.”

At the same time, they pointed out, demographic changes will lead to a falling labour force throughout the coming decade.

“Increasing awareness of environmental issues, in particular the global climate problems, also implies a larger role for tax policy as one of the instruments to fulfil future more ambitious environmental objectives.” the ‘wise men’ added.

“A sensible tax reform should consider the whole tax system simultaneously as the various elements typically affect each other,” the chairmanship of the Danish Economic Council said. “In particular this is true for the direct taxation of labour and capital incomes and for the indirect taxation of goods and services.”